REASONS
FOR JUDGMENT
Paris J.
[1]
This is an appeal from a reassessment of the
Appellant’s 1998 taxation year, by which the Minister of National Revenue (the “Minister”) disallowed a portion of the resource
allowance claimed by the Appellant pursuant to now‑repealed paragraph
20(1)(v.1) of the Income Tax Act (the “Act”).
[2]
The resource allowance enabled mineral producers
to deduct a percentage of their income earned from producing and processing
minerals, and was added to the Act to compensate for the
non-deductibility of Crown royalties. The amount of a taxpayer’s
resource allowance was dependent on the taxpayer’s gross resource profits
determined under the Income Tax Regulations (the “Regulations”).
[3]
The issue in this appeal is whether the profit
earned by the Appellant when it closed out certain derivative instruments in
1998, that it had entered into in order to hedge the price of gold it expected
to produce, constitute gross resource profits pursuant to subsection 1204(1) of
the Regulations.
[4]
For the reasons that follow, I find that the
profit falls within the definition of “gross resources profits” and that the
Appellant is therefore entitled to the full resource allowance claimed.
Facts
[5]
In 1998, the Appellant was in the business of
producing and processing gold in Canada. It had interests in three mines. It
owned the Holt-McDermott Mine and the Bousquet Mine, and held a 50% interest in
the Doyon Mine. The other 50% interest in the Doyon Mine was held by Cambior
Inc., an arm’s-length party.
[6]
To hedge the risk associated with fluctuations
in the price of gold, the Appellant would enter into derivatives in respect of
its anticipated gold production.
[7]
The Appellant recognized any profits or losses
from its hedges of its gold production as income or loss from its business of
producing and processing gold.
[8]
The Appellant included any profits or losses
from its hedges of its gold production in computing its gross resource profits
for purposes of computing its resource allowance, and except for the amounts in
issue in this appeal, the Minister accepted this position.
[9]
Prior to 1998, the Appellant entered into derivatives
known as spot deferred forward contracts to hedge some of its anticipated gold
production from each of its mines. These contracts included three spot deferred
forward contracts (the “Forward
Contracts”) to hedge anticipated production of
300,000 ounces of gold from the Doyon Mine.
[10]
On January 19, 1998, the Appellant entered into
a letter of intent to sell its interest in the Doyon Mine to Cambior Inc. The
letter of intent was subject to a number of conditions.
[11]
On January 20, 1998, the Appellant entered into
contracts to purchase 300,000 ounces of gold at the then current spot price
from a third party. On January 26, 1998, the Appellant took delivery of the
gold and used it to close out the Forward Contracts.
[12]
All of the conditions relating to the sale of
the Appellant’s interest in the Doyon Mine to Cambior Inc. were fulfilled and,
on January 27, 1998, the Appellant entered into a purchase agreement with
Cambior Inc. (the “Purchase
Agreement”) and sold its interest in the Doyon
Mine. The Purchase Agreement provided that the transfer of the Appellant’s
interest was deemed to have occurred on January 1, 1998 (the “Deemed Transfer Time”) and that the Appellant was not entitled to any production or
revenue derived after January 1, 1998 from the transferred interest, except to
the extent of the Appellant’s “Participation
Right” in the mine. The Participation Right was
an amount payable annually to the Appellant if the average price of gold
exceeded $375 U.S. per ounce. No amount was paid in respect of the
Participation Right in 1998.
[13]
The Appellant realized a profit of $56,679,461 when
it closed out the Forward Contracts.
[14]
On its 1998 financial statements, the Appellant
reported the profit from the closing out of the Forward Contracts as part of
the “Gain on Sale” of its
interest in the Doyon Mine. Proceeds from the
sale of gold produced from the Holt‑McDermott Mine and the Bousquet Mine,
as well as profits from the closeout of derivatives in respect of gold sales
from those two mines were reported as “Gold Sales Revenue”. “Gain on Sale” and “Gold Sales
Revenue” were separate line items on the
financial statements.
[15]
For tax filing purposes, the Appellant included
the profit on the Forward Contracts as well as the amount reported on the
financial statements as “Gold Sales Revenue” from the Holt-McDermott and Bousquet
Mines in its gross resource profits for 1998 and computed its resource allowance
on the combined amount.
[16]
The Minister allowed the inclusion of the Gold
Sales Revenue in the calculation of gross resource profits but disallowed the inclusion
of the profit from the Forward Contracts.
[17]
It is not disputed that the profit earned by the
Appellant on the Forward Contracts was on income account. The parties also
agree that the Appellant did not enter into the Forward Contracts for the
purpose of speculation and that its sole intention was to hedge the risk of
fluctuations in the price of gold that it expected to produce from the Doyon
Mine. Finally, the parties also agree that the Appellant had no intention of
speculating on the price of gold when it purchased the gold required to close
out the Forward Contracts.
Statutory Scheme
[18]
For the 1998 taxation year, paragraph 20(1)(v.1)
of the Act permitted a taxpayer to claim a deduction in respect of such
amount as was allowed by regulation in respect of mineral resources in Canada.
The deduction was referred to as the “resource allowance”.
[19]
The relevant portions of paragraph 20(1)(v.1)
of the Act read, at the time, as follows:
20(1) Notwithstanding paragraphs 18(1)(a),
(b) and (h), in computing a taxpayer’s income for a taxation year from a
business or property, there may be deducted such of the following amounts as
are wholly applicable to that source or such part of the following amounts as
may reasonably be regarded as applicable thereto:
(v.1) such amount as is allowed to
the taxpayer for the year by regulation in respect of natural accumulations of
petroleum or natural gas in Canada, oil or gas wells in Canada or mineral
resources in Canada;
…
[20]
Subsection 1210(1) of the Regulations
provided for a resource allowance of 25% of an amount based on the taxpayer’s “adjusted
resource profits”. “Adjusted resource profits” depended on “resource profits”,
which, in turn, depended on “gross resource profits”. A taxpayer’s “gross
resource profits” were computed pursuant to subsection 1204(1) of the Regulations. The relevant portions of subsection 1204(1)
read, at the time, as follows:
1204(1) For the purposes of this Part,
“gross resource profits” of a taxpayer for a taxation year means the amount, if
any, by which the aggregate of
…
(b) the amount, if any, of the
aggregate of his incomes for the year from
…
(ii) the
production and processing in Canada of
(A) ore, other
than iron ore or tar sands ore, from mineral resources in Canada operated by
him to any stage that is not beyond the prime metal stage or its equivalent,
[21]
The relevant portion of the definition of “production”
was found in subsection 66(15) of the Act:
“production” from a Canadian resource
property or a foreign resource property means
…
(c) ore (other than iron ore or tar
sands) produced from the property processed to any stage that is not beyond the
prime metal stage or its equivalent…
Respondent’s Position
[22]
The Respondent submits that the legislative
framework for computing the resource allowance is restrictive and that the
allowance is permitted only with respect to income generated from mineral resources
in Canada. The definition of “gross
resource profits”, found in subsection 1204(1)
of the Regulations, limits gross resource profits to specific sources of
income, including “the production and processing in Canada of ore … from mineral
resources in Canada operated by him to any stage that is not beyond the prime
metal stage or its equivalent.” The Respondent refers to the decision of the Federal Court of
Appeal in Gulf Canada Ltd. v. Canada, 92 DTC 6123 to the effect that
income from production and processing as defined under subsection 1204(1) is a
narrow concept restricted to extraction from the ground.
[23]
In this case, the Respondent takes the position
that the profit on the closeout of the Forward Contracts cannot be connected to
production and processing of gold from the Doyon Mine in 1998 because the
Appellant did not carry out any production or processing from the Doyon Mine on
its own account as of January 1, 1998. Therefore, the Respondent says that the
profit does not meet the test set out in 3850625 Canada Inc. for
inclusion in gross resource profits, which requires that there be a sufficient
connection between the amount and the taxpayer’s production and processing
activities.
[24]
The Respondent relies on the fact that, under
the Purchase Agreement, the transfer of the Appellant’s 50% interest in the
Doyon Mine to Cambior Inc. was deemed to be effective as of January 1, 1998 and
any gold production or processing related to the Doyon Mine after that date was
on Cambior Inc.’s account. Therefore, the Respondent submits that the Appellant
was not entitled to revenue from the production of gold, if any, from the Doyon
Mine from January 1, 1998 to the closeout date of the Forward Contracts on
January 26, 1998.
[25]
The Respondent says that, given the absence of
any production or processing of gold ore from the Doyon Mine by the Appellant
in 1998, the profit on the Forward Contracts cannot be connected to any
production or processing activities of the Appellant and the profit cannot
qualify as gross resource profits under subsection 1204(1) of the Regulations.
[26]
The Respondent says that this case is
distinguishable from that of Echo Bay Mines Ltd. v. The Queen, 92 DTC
6437, in which the Federal Court, Trial Division, held that profits earned by
the taxpayer mining company from hedging transactions entered into to fix the
price of its anticipated silver production were part of its gross resource
profits for the purpose of the resource allowance. While the Respondent
recognizes that income earned from hedging mineral production may form part of gross resource profits pursuant to subsection 1204(1) of the Regulations, counsel
says that the income in issue in this case did not arise from hedging
transactions. The Respondent says that the Forward Contracts ceased to be
hedges prior to their closeout because as of January 19, 1998, at the latest,
the Appellant no longer anticipated any future gold production from the Doyon
Mine. With no anticipated production, there was no longer any risk associated
with the fluctuation of the price of gold from the Doyon Mine. Since the risk
that the Forward Contracts were intended to hedge no longer existed, the
Contracts ceased to be hedges and the profit on the closeout of the Contracts
could not be considered to relate to the income generated from the business of
producing and processing gold from the Doyon Mine.
[27]
In support of its position that the Forward
Contracts ceased to be hedges prior to being closed out, the Respondent relies
on the expert accounting evidence given at the hearing by Ms. Patricia O’Malley.
Ms. O’Malley testified that a hedging relationship is established between a
hedged item and a hedging item. The hedged item exposes the entity to the risk
of price fluctuations and the hedging item is expected to offset that risk. According
to Generally Accepted Accounting Principles (GAAP), in the context of mineral
production and sales, if a valid hedging relationship exists, total revenue
from the sale of the mineral would consist of revenue from the actual sale of
the mineral plus the offsetting income gains or losses from the corresponding
hedging item, which is typically a derivative instrument. However, if the
hedging relationship ceases, income gain or losses from the hedging item must
be reported separately from the sale of the mineral.
[28]
Ms. O’Malley further testified that the Forward
Contracts in this case ceased to be hedges for accounting purposes once the
Appellant no longer anticipated future production from the Doyon Mine. She said
that this occurred when the Appellant entered into the conditional agreement on
January 19, 1998 to sell its interest in the Doyon Mine.
[29]
Therefore, she said that in the absence of a
hedging relationship, the income earned by the Appellant on the closing out of
the Forward Contracts was required by GAAP to be reported separately from
revenue from the sale of gold produced from the Doyon Mine. This, the
Respondent’s counsel points out, is how the Appellant accounted for the profit
on the Forward Contracts in its financial statements. Therefore, counsel says
that the Appellant’s own accounting treatment of the profit on the Forward
Contracts conclusively demonstrates that the company did not consider that the
profit from the closeout of the Forward Contracts was connected to its gold
production from the Doyon Mine. Without such connection, the profit cannot
enter into the computation of gross resource profits.
[30]
Ms. O’Malley also stated that, according to
GAAP, where a hedging relationship ceases to exist, the profit is considered to
be attributable to speculative activity. The Respondent maintains, therefore,
that the profits earned on the Forward Contracts was income from speculative
activities and, as such income is not within the scope of gross resource
profits, it cannot be taken into account in computing the resource allowance.
[31]
The Respondent’s final argument is that, as
stand-alone transactions, the Forward Contracts cannot be considered to be
related to the Appellant’s production and processing of gold from the Doyon
Mine. The Respondent says that the profit on the Forward Contracts resulted
from the delivery of gold purchased by the Appellant from a third party and not
from the delivery of gold originating from the Appellant’s own production and
processing activities and is therefore connected to the third party’s
production and processing activities, rather than the Appellant’s.
Analysis
[32]
The question to be decided is whether the profit
earned by the Appellant on the closeout of the Forward Contracts constituted
gross resource profits within the meaning of paragraph 1204(1)(b) of the
Regulations.
[33]
The test to be applied is that set out in 3850625
Canada Inc. v. Canada, 2011 FCA 117. In that case, the Federal Court of
Appeal upheld the decision of this Court by Woods J. that refund interest
earned on the overpayment of the taxpayer mining company’s income taxes was
properly included in calculating its resource allowance. The Federal Court of
Appeal confirmed that the test for whether an item of income should be included
in gross resource profits is “whether the [income in question is] sufficiently
connected to the [taxpayer’s] production and processing activities to
constitute income from that source” and also stated that “income amounts are
included in the computation of the resource allowance where they are related to
production as a source of income” (at paras 20 and 21).
[34]
I will deal firstly with the Respondent’s
position that the Appellant did not produce or process gold from the Doyon Mine
in 1998 and that there were therefore no relevant activities to which the
Forward Contract profits could be connected for the purposes of subsection
1204(1) of the Regulations.
[35]
While the Respondent purports to accept the test
laid down by the Federal Court of Appeal in 3850625 Canada Inc.,
counsel’s initial contention that income from production and processing as
defined in subsection 1204(1) is “a narrow concept restricted to extraction
from the ground” is one that was specifically rejected in that case. At
paragraphs 20 and 21 of the decision in 3850625 Canada Inc., the Court
wrote:
[20] However, on appeal, the Crown contends
that the construction that was given to the phrase “production and processing”
in Gulf is more restrictive and that the Tax Court Judge erred in
failing to follow that approach. In particular, the respondent refers to the
following passage of the reasons of McNair J. at paragraph 44:
I am satisfied to accept the
submissions of plaintiff's counsel on this issue, namely, that sections
124.1 and 124.2 are much more specific in their scope and intendment than the
calculation of income provisions under section 3 of the Act, in requiring that
the income and deductions be related to production in the sense of extraction
from the ground as the source of income. In my opinion, the scientific
research expenditures in issue, being related to the long-term objectives of
the plaintiff and not to the actual present production from mineral resources,
ought not to be included in the calculations. …
[Emphasis added]
[21] I do not read this passage as providing
for an approach that is more restrictive than the one adopted by the Tax Court
Judge. The reasoning is that in order to qualify for inclusion in the
computation of “taxable production profits”, the income (or the deductions)
must be related to production in the narrow sense of extraction from the
ground as a source of income. This does not restrict the qualifying activity to
extraction per se. As was made clear on appeal, extraction per se
is not a source of income; only the “business of production” can give rise to
income (see the decision of the Appeal Division at p. 6127). In my respectful
view, the Gulf test is consistent with the one set out in Echo Bay
Mines and which the Tax Court Judge applied in this case, i.e.
whether the refund interest was sufficiently connected to the production and
processing activities to constitute income from that source. I therefore reject
the contention that the Tax Court Judge applied the wrong legal test.
[36]
According to 3850625 Canada Inc., then, the
relevant nexus for determining gross resource profits is between the taxpayer’s
business of production, as opposed to the more narrow nexus between the income
and the physical act of extracting resources.
[37]
I find that the Respondent’s position that the
income in question must be specifically referable to production and processing
activities carried on by the Appellant in 1998 to be too restrictive. I do not
accept that it is necessary to relate the Forward Contract profits to
production and processing activities carried out in relation to the Doyon Mine
in the 1998 taxation year alone in order for the profit to be “sufficiently
connected to the production and processing activities to constitute income from
that source.” In 3850625 Canada Inc., the Federal Court of Appeal upheld
the decision of Woods J. of this Court that interest paid to the taxpayer in
1996 in respect of an overpayment of tax relating to its 1985 to 1990 taxation
years was sufficiently connected to its production and processing activities to
enter into the computation of its resource allowance for the 1996 taxation
year. In determining that the refund interest was sufficiently connected, Woods
J. took into account that the issues giving rise to the appeal were “primarily related to activities that are integral
to production and processing.” Those issues
arose in the earlier years and not in the year the interest was received. Despite
the fact that the tax refund was received several years after the resource
activities were completed in the 1985 to 1990 taxation years, Woods J. found
that the refund interest was properly included in the computation of the
taxpayer’s resource allowance.
[38]
In 3850625 Canada Inc., Woods J. also
rejected the Crown’s contention that there was insufficient connection “because
income tax is not paid in the course of the resource business but after the
resource activities were completed.” In doing so, she relied on the decision of
the Federal Court of Appeal in Munich Reinsurance Company (Canada Branch).
v. The Queen, 2001 FCA 365 and Irving Oil Ltd. v. The Queen, 2001
FCA 364, in which the Court found that “the right of the appellant to be
paid its tax overpayments was a right acquired in the course of carrying on its
business.”
[39]
In this case, the Forward Contracts were entered
into and closed out in the course of the Appellant’s business of production and
processing from the Doyon Mine. There is no doubt on this point. The Respondent
admits that the Appellant’s sole reason for entering into the Forward Contracts
was to hedge the risk of price fluctuations in the price of gold that it
expected to produce from the Doyon Mine. Furthermore, the evidence showed that
the Appellant regularly entered into derivative financial instruments to reduce
the risk associated with price volatility it was exposed to in the course of
carrying on its gold producing and processing business and to stabilize the
revenues it earned in the course of carrying on that business. Finally, the
Appellant’s only source of income both at the time the Forward Contracts were
entered into and closed out was that business.
[40]
On the basis of this evidence, I find that the
Forward Contracts were an integral part of the Appellant’s business of
producing and processing gold ore and therefore that the profit that arose from
closing out the Contracts were sufficiently connected to those activities to
constitute income from that source and therefore are properly part of its gross
resource profits in 1998.
[41]
I reject the Respondent’s next argument that this
case is distinguishable from Echo Bay Mines because the Forward
Contracts ceased to be hedges and therefore ceased to be connected to the
Appellant’s producing and processing activities at the moment the Respondent
agreed to sell its interest in the Doyon Mine to Cambior Inc. I find that this
view of what took place to be highly artificial, since it is admitted that the
Appellant’s sole intention in entering into the Forward Contracts was to hedge
the price of gold produced from the Doyon Mine.
[42]
In this case, there is no evidence of a change
of intention on the part of the Appellant with respect to the Forward Contracts,
and the steps taken to close them out immediately after the decision to sell
its interest in the Doyon Mine was made, supports the Appellant’s position that
the Contracts were entered into solely to mitigate the risk of price
volatility. Furthermore, the Respondent has admitted that the Appellant had no
speculative purpose when it purchased the gold used to close out the Forward
Contracts. The Forward Contracts were activities reasonably connected with
marketing intended production from the Doyon Mine and served no other purpose.
The following statement by MacKay J. at page 6447 of the Echo Bay Mines
case is, in my view, equally applicable here:
…Activities reasonably interconnected with
marketing the product, undertaken to assure its sale at a satisfactory price,
to yield income, and hopefully a profit, are, in my view, activities that form
an integral part of production which is to yield income, and resource profits,
with Regulation 1204(1).
[43]
I also find that the accounting treatment of the
profits on the Forward Contracts is not determinative of the nature of that
profit for income tax purposes. In Shell Canada Ltd. v. Canada, [1999] 3
SCR 622, Iaccobucci J. wrote that “[t]his Court has
frequently held that accounting practices, by themselves, do not establish
rules of income tax law”(at para 73). In Canderel Ltd. v. Canada, [1998] 1
S.C.R. 147, Iaccobucci J. also wrote that:
…well-accepted
business principles are not rules of law and thus a given principle may not be
applicable to every case. More importantly, these principles must
necessarily take a subordinate position relative to the legal rules which
govern. (at para 35)
[44]
The test for whether income earned by a taxpayer
falls within the definition of gross resource profits is a legal test and has
been decided in 3850625 Canada Inc. Thus there is no need to resort to
accounting principles to assist in the required determination and it is immaterial
how the profit earned on the Forward Contracts was required to be treated for
financial statement purposes.
[45]
Given my conclusion that the Forward Contracts
did not cease to be hedges prior to being closed out, it is not necessary to
deal with the Respondent’s further argument that the Contracts should be considered
“stand-alone transactions” and that the gold used to satisfy the Contracts was
produced by third parties. I would only note that there is no need for a
taxpayer to fulfill a hedge contract with production from its own mine in order
to have a valid hedge: Placer Dome Canada Ltd. v. Ontario (Minister
of Finance), 2006 SCC 20 at para 52.
[46]
For all of these reasons, the appeal is allowed
and the matter is referred back to the Minister for reassessment on the basis
that the profit earned by the Appellant on the Forward Contracts be included in
the Appellant’s gross resource profit for the purposes of determining its
resource allowance for 1998.
Signed at Vancouver,
British Columbia this 1st day of February 2017.
“B.Paris”
Email this Content